On February 18, PayPal contacted ebook distributor Smashwords with an ultimatum: Remove certain types of erotic ebooks (featuring underage characters, incest, bestiality, and rape), or face deactivation of their PayPal account. Since PayPal is integrated into the Smashwords website, they had no choice but to remove the “edgy” erotica identified by PayPal as “unlawful.” No U.S. court had ever found any of the ebooks in question illegal, but that was rather beside the point for PayPal, who seemed to be confusing illegal sexual activities with legal depictions of those activities.

What started as a dispute between a payment processor (PayPal) and a handful of ebook stores (including Smashwords) snowballed into a widely circulated petition from the Electronic Freedom Foundation (signed by the Authors Guild, the CBLDF, and the ACLU, among others) asking PayPal to reverse their policy.

“What I find chilling is that the money exchanger, not the merchant, can make such a decision,” commenter L.K. Rigel wrote on a Dear Author blog post, where news of PayPal’s actions was first reported. “PayPal is, after all, basically a bank. So now a bank gets to decide what customers can buy or merchants can sell? The decision is only palatable because they’re cutting off stuff people mostly find abhorrent.”

When PayPal allegedly tried to lay the blame on credit card companies’ terms of service, Visa flipped a finger right back. “Visa takes no position with respect to lawful goods and services bought and sold by the people and the companies who use our payment service,” Visa’s Investor Relations wrote in a letter to BannedWriters.com. “We want to clarify that Visa had no involvement with PayPal’s conclusion on this issue.”

After Visa clarified their position on credit card usage (“anything legal”), PayPal’s excuse (“the credit card companies are making us do this!”) fell apart and they had to admit defeat. On March 13, PayPal announced an updated policy with regards to handling ebook transactions that “will prohibit use of PayPal for the sale of e-books that contain child pornography, or e-books with text and obscene images of rape, bestiality or incest… In addition, the policy will be focused on individual books, not on entire ‘classes’ of books.”

PayPal’s policy change represented a win for online retailers as well as for freedom of expression “This is going to be a major victory for writers, readers and free speech,” said Smashwords’ Mark Coker.